A Grave Threat

February 12, 2010Olivier Blanchard, the IMF’s top economist, is calling for a doubling or tripling in the rate of inflation. He wants central bankers to raise their inflation targets to 4%-6% from an average of 2% today. What would possess anyone to recommend more inflation? Mr. Blanchard thinks a higher inflation rate would allow for greater flexibility in times of financial crisis. You can’t make this stuff up.The beneficiaries of Mr. Blanchard’s inflation scheme would, of course, be spendthrift governments. The burden of government debt falls sharply in inflationary environments. But while governments would benefit from higher inflation, just about everyone else would lose under Mr. Blanchard’s inflation scheme. Workers and retirees would get hammered through the inflation stealth tax. Banks would get slammed because the valuable dollars they lend out would be returned as cheaper dollars. Businesses would face greater uncertainty about costs. And investors’ portfolio values would plummet as a result of higher interest rates.The chart below shows the savage 64% drop in the purchasing power of the dollar since 1980 during a period of “normal” inflation averaging 3.5% a year. Imagine how quickly your dollars would become worthless if inflation were set at 4%-6%. Mr. Blanchard’s proposal is a threat to all retired and soon-to-be-retired investors. Be sure your portfolio has adequate inflation protection.